United States Tax Court
DONALD FURRER AND RITA FURRER, Petitioner s v .
COMMISSIONER OF INTERNAL REVENUE, Respondent ————— Docket N o. 7633- 19. Filed September 28, 2022.
————— Anita L. Steburg , for petitioner s .
Kristin M. Bourland , Stephen A. Haller, Joline M. Wang , and Philip Edward Blondin, for respondent.
MEMORANDUM OPINION
LAUBER, Judge : P etitioner s seek redetermination of deficiencies determined by the Internal Revenue Service (IRS or respondent) in connection with two charitable remainder annuity trusts (CRATs). Petitioners, who were engaged in the farming business, made in-kind transfers of agricultural crops to the CRATs in 2015 and 2016 . The CRATs sold the crops and used the proce eds to purchase a nnuity plans . During 2015– 2017 the annuity plans made cash distributions to petitioners. After concessions two questions remain for decision , which respondent has presented by M otion for P artial Summary J udgment : (1) whether petitioners are entitled under section 1701 to noncash charitable contribution deductions for 2015 and 2016 for portion s of the crops [*2] transferred to the CRATs; and (2) whether the annuity distributions were taxable to pe titioners as ordinary income for 2015– 2017. We resolve both questions in respondent’s favor.
Background
There is no dispute as to the following facts, which are drawn from the parties’ joint Stipulation of F acts, motion papers, and exhibits and declarations attached thereto. Petitioner s resided in Indiana when they timely petitioned this Court.
During 2015– 2017 petitioners were actively engaged in the farming business, growing and selling corn and soybeans. In July 2015, a fter se eing an advertisement in a farming magaz ine , petitioners formed the Donald & Rita Furrer Charitable Remainder Annuity Trust of 2015 (CRAT I) , of which their son was named trustee. The trust instrument designated petitioners as life beneficiaries and three eligible section 501(c)(3) charities as remaindermen.
When forming CRAT I p etitioners transferred to it 100,000 bushels of corn and 10,000 bushels of soybea ns grown on their farm. In August 2015 CRAT I sold the crops for $469,003. The sales were effect ed by Co - Alliance LLP, a grain marketing and storage facility in Av on, Indian a, where peti tio ners stored the crops. CRAT I distribut ed $47,000 of t he proceeds to the charitable remaindermen and used most of the balance to purchase a Single Premium Immediate Annuity (SPIA) from Symetra Life Insurance Co. (Symetra) . The SPI A made annual annuity paymen ts of $84,368 to petitioners in 2015 – 2017.
For each year Symetra issued to the trustee a Form 1099 – R, Distributions From Pensions, Annuities, Retirement or Profit - Sharing Plans, IRAs, Insurance Contracts, etc. These forms listed the annuity payments as “ g ross d istributions ” and showed a small amount of interest as the “ t axable amount . ” On January 13, 2016, petitioners created the Donald & Rita Furrer Charitable Remainder Annuity Trust of 2016 (CRAT II). Following the previous pattern, petitioners designated themselves as life beneficiaries , with the remainder going to seven eligible s ection 501(c)(3)
[*3] c harities. P etitioners funded CRAT II by transferring to it 111,335 bushels of corn and 31,064 bushels of soybeans grown on their farm.2 In April 2016 CRAT II sold the crops for $69 1,827. The sales were again effected by Co - Alliance LLP, the grain marke ting and storage facility where petitioners stored the crops . CRAT I I distributed $ 69,294 of the proceeds to the charitable remaindermen and used the balance to purchase a nother SPIA from Symetra . Th is SPIA made annual annuity payments o f $124, 921 to petitioners in 2016 and 2017. Symetra again issued a Form 1099– R to the tru stee , listing the annuity payments as “ g ross d istributions ” and showing a small amount of interest as the “ t axable amount . ” Petitioners timely filed joint Federal income tax re turns for 2015– 2017. They attached to each return a Schedule F, Profit or Loss F rom Farming, reporting farming income and expenses as follows :
2015 2016 2017 Income $1,050,571 $ 294,595 $159,797 Expenses (1,058,051) (247,476) (152,308)
Total Profit/(Loss) ( $ 7,480) $ 47,119 $ 7, 489
On their 2015 and 2016 returns petitioners claimed charitable contribution deductions for cash gifts but claimed no deductions for their in-kind c rop transfer s to the CRATs . On each return they reported interest income from the SPIA as shown on the Form 1099 – R issued to the trustee. But they did not repo rt the balance of the annuity distributions , taking the position that these payments constituted a nontaxable return of corpus under section 664(b) (4).
For 2015 and 2016 petitioner husband filed Form s 709, U nited States Gift (and Generation - Skipping Trans fer) Tax Return . On the 2015 return he reported that petitioners had contributed to CRAT I corn and soybeans with a fair market va l ue (F M V) of $ 469,003 and a cost basis of zero. On the 2016 return he reported that petitioners had contributed to CRAT II c orn and soybeans with a n FMV of $ 666,975 and a cost basis of zero.
[*4] For each year the trustee filed for each CRAT a Form 5227, Split -Interest Trust Information Return. The trustee attached to each of the 2015 and 2016 information returns a Form 4797, Sales of Business Property, reporting sale of the crops contributed by petitioners. For 2015 he reported that CRAT I had received proceeds of $469,003 f rom sale of crops with a basis of $471,000, for a loss of $1,997. For 2016 he reported that CRAT II had received proceeds of $691,827 f rom sale of crops with a basis of $666,975, for a gain of $ 24,852.
The IRS selected petitioners’ 2015 – 2017 income tax returns for examination . It determin ed that their characterization of the SPIA distributions as n ontaxable return s of corpus under section 664(b) (4) was improper. Rather, the examining agent concluded that these distributions represented proceeds from the sale of petitioners’ corn and soybeans and as such were taxable to them as ordinary income . The IRS accordingly increased their Sc hedule F farm income by $83,440 in 2015 and by $206,967 in 2016 and 2017.3
During the examination petitioner s contended that they had neglected to claim on their 2015 and 2016 returns, but should be allowed, noncash charitable contribution deductions for portion s of their donations to the CRAT s . In petitioner s’ view, the allowable deducti on for each year was equal to the proportion of the FMV of the donat ed crops that was destined to the charitable remaindermen. Petitioners had not secured an appraisal for either donation or attached a Form 8283, Noncash Charitable Contributions, to their 2015 or 2016 income tax return. The examin ing agent nevertheless agreed with their position and allowed ad d itiona l charitable contribution deductions of $67, 7 88 for 2015 and $106,413 for 2016.4
The IRS issued petitioners a timely notice of deficiency determining deficiencies of $55,040, $56,904, and $95,907 for 2015– 2017, respectively, plus accuracy-related penalties. The IRS has conceded the [*5] penalties for inability to show timely supervisory approval. See § 6751(b) (1). On November 22, 2021, we granted respondent’s M otion for L eave to A mend A nswer to disallow the noncash charitable contribution deductions that the examining agent had a llowed for 2015 and 2016.
On January 28, 2022, respondent filed a M otion for P artial Summary J udgment, to which petitioners timely replied. On November 1, 2021, and April 11 , 2022, the parties filed S tipulations of Settled I ssues that resolve all issues in this case apart from the two issues presented by respondent’s summary judgment motion. Those issues are : (1) whe -ther petitioners are entitled to noncash charitable contribution deductions for 2015 and 2016, and (2) whether the annuity distributions were taxable to petitioners as ordinar y income in 2015 – 2017.
Discussion
A. Summary Judgment Standard
The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). We may grant summary judgment regarding an issue as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. , 98 T.C. 518, 520 (1992), aff’d , 17 F.3d 965 (7th Cir. 1994). Petitioners have alleged no genuine dispute of material fact affecting the question s that respondent h as proposed for summary judgment . We conclude that these question s may appropriately be adjudicated summarily. B . Charitable Contribution Deductions During the examination petitioners raised , as an affirmative issue , their alleged entitlement to noncash charitable contribution deductions for portion s of the crops they transferred to the CRATs. The examining agent allowed such deductions. By timely amended answer, respondent contends that the examining agent erred and that these deductions should be disallowed. Because this is a “ new matter , ” respondent bears the burden of proof on this point . See Rule 142(a) (1). We conclude that respondent has carried his burden and that the deductions are impermissible .
[*6] [*7] 2 . Application of Section 170(e)(1)
Even if petitioners had complied with the statutory s ubstanti ation requirement s, they would not be entitled to charitable contribution deduction s for donating to the CRATs bushels of soybean s and corn , which we re ordinary income property in their hands . Section 170(e)(1)(A) provides that the deduction otherwise allowable for a contribution of property shall be reduced by “the amount of gain which would not have been long-term capital gain . . . if the property contributed had been sold by the taxpayer at its fair market value ( determined at the time of such contribution ) .”
Inventory held primarily for sale to customers in the regular course of a trade or business is ordinary income property . N o portion of the gain from the sale of such property could be long-term capital gain. § 1221(a)(1). Thus, the deduction for a contribution of ordinary income property is typically limited to the donor’s cost basis in the property. See Jones v. Commissioner , 560 F.3d 1196, 1199 (10th Cir. 2009) , aff’g 129 T.C. 146 (2007) ; Strasburg v. Commissioner, T.C. Memo. 2000-94, 79 T.C.M. (CCH) 1697, 1704 (“The allowable charitable contribution deduction for ordinary income property is limited to the basis of the property donated . ”) Accordingly, i f a taxpayer has zero bas is in ordinary income property, section 170(e)(1)(A) “ require [s ] that the deduction for donating that property be reduced by the property’s entire value — leaving the taxpayer with no deduction at all .” Jones v. Commissioner, 560 F.3d at 1199; see Lary v. U nited States , 787 F.2d 1538, 1540– 41 (11th Cir. 1986); Conn e r v. Commissioner, T.C. Memo. 2018-6, 115 T.C.M. (CCH) 1013, 1023, aff’d , 770 F. A pp’x 1016 (11th Cir. 2019) .
Petitioners were engaged in the farming business, and the corn and soybeans grown on their farm constituted ordinary income property. Thus, any charitable contribution deduction would be limited to t heir cost or adjusted basis in the crops. See Jones v. Commissioner , 560 F.3d at 1199. As petitioner husband conceded when filing the 2015 and 2016 gift tax returns, petitioners’ basis in the corn and soybeans transferred to the CRATs was zero. See supra p . 3 . That was because petitioners had fully expensed , on their 2015 and 2016 income tax returns, all the costs of growing the c ro ps . See supra p. 3 . In order to have a basis in the donated crops, petitioners would have had to incur, with respect to § 170(f)(11)(A)( ii)(II). Petitioners do not contend that they could make this showing , and they have advanced no argument to this effect in their response to the summary judgment motion.
[*8] those crops, farming expenses in addition to th ose deducted o n their 2015 and 2016 income tax returns. They do not allege that they incurred any such additional farming expenses. Accordingl y, th e available deduction for the transfers of corn and soybeans to the CRAT s is reduced to zero under section 170(e)(1 )(A).
C . Taxability of CRAT Distribution s
1 . Governing Statutory Structure A CRAT is a type of charitable remainder trust (CRT). In general, a CRT provides for annual distributions to the grantor (or other noncharitable life beneficiaries) and an irrevocable remainder interest designated for one or more qualified charit ies. See § 664; Treas. Reg. § 1.664-1(a). A trust is a CRT only if it is a CRAT or a charitable unitrust. See Treas. Reg. § 1.664-1(a)(2).
As a rule, no gain is recognized by the donor upon transfer of appreciated property to a CRT . See Bu ehner v. Commissione r , 65 T.C. 723, 740 (1976) ( “ A gift of appreciated property [to a CRT] does not result in income to the donor . . . .” ( quoting Humacid Co. v. Commissioner , 42 T.C. 894, 913 (1964) ) ) . A nd because CRTs are exempt from income tax, appreciated property can be sold by the trust tax free. See § 664(c)(1); Treas. Reg. § 1.664-1(a)(1)(i). Howe ver, notwithstanding a CRT’s tax -exempt status, the income earned by the trust is taxable to its inco me beneficiaries upon distribution. See Alpha I, L.P. v. United States, 682 F.3d 1009, 1015 (Fed. Cir. 2012) (citing section 664(b) and (c)(1)). Congress has set forth specific ordering rules that govern the characterization and reporting of annuity amounts distributed by a CRA T to its income beneficiaries. See § 664(b) .6
Under this regime, distributions from a CRAT to income beneficiaries are deemed to have the following character , and to be distributed in the following order: f irst, as ordinary income , to the extent of the trust ’ s current and previously undistributed ordinary income; s econd, as capital gain , to the extent of the trust’ s current and previously undistributed capital gain; t h ird, as other income , to the extent of the trust’ s current and previously undistributed other income; and f ourth, a s a nontaxable distribution of trust corpus. § 664(b)(1) ‒(4).
[*9] We have previously discussed the application of section 664(b) and the t reatment of CRAT distributions. See Miller v. Commissioner, T.C. Memo. 2009-182, 98 T.C.M. (CCH) 87. A distribution from a CRAT is deemed to consist first of income that is subject to the highest Federal tax rate (ordinary income) , and then, upon exhaustion of that class, of income subject to progressively lower tax rates . Only after all taxable income has been distributed is a beneficiary deemed to receive a nontaxable return of corpus . See id . at 88 – 89 . CRATs are subject to strict report ing requirements to ensure compliance with the statutory ordering rules . See § 4947(a)(2); Treas. Reg. § 1.664-1(a)(1)(ii). A CRAT must file an annual information return on Form 5227 reflecting its income, deductions, accumulations, and distributions for the year. See § 6011; Treas. Reg. § 53.6011-1(d). I t must issue to each income beneficiary a Schedule K – 1 , Beneficiary’s Share of Income , Deductions, Credits, etc., properly describing the tax character of all distributions . See § 6034( a) ; Treas. Reg. § 1.6012-3(a)(6). And i t must maintain a record of the basis of all property contributed to it. See § 1015(a).
2 . Analysis As petitioner husband conceded when filing the 2015 and 2016 gift tax returns, petitioners’ basis in the corn and soybeans t ransferred to the CRAT s was zero. That was because petitioners had fully expensed, on their 2015 and 2016 income tax returns, all the costs of growing the c ro ps. See supra p. 7. Section 1015 provides that , if property is transferred (in trust or otherwise) by gift, “the basis shall be the same as it would be in the hands of the donor ,” increased by any gift tax paid on the transfer. See § 1015(a), ( d ) . The transferee acquires an FMV basis only if the donor ’ s basis was “greater than the fa i r market value of the property at the time of th e gift. ” § 1015(a). Section 1 015(a) applies to property “acquired by gift after December 31, 1920. ” T hese basic tax principles have thus been established for a very long tim e. See Veterans Found. v. Commissioner , 38 T.C. 66, 72 (1962), aff’d , 317 F.2d 456 (10th Cir. 1963) ; Magness v. Commissioner, T.C. Memo. 1965-260, 24 T.C.M. (CCH) 1413.
Petitioners did not pay any gift tax upon transfer of the crops to the CRATs . Under section 1015(a) , each CRAT thus acquired a basis of zero in the corn and soybeans, the same basis that the crops had in petitioners’ hands. The FMV of the transferred crops is irrelevant in [*10] determining the CRATs’ basis because petitioners’ basi s was lower than the FMV of the crops . See § 1015(a).
CRAT I and CRAT II sold the corn and soybeans transferred to them for $469,003 and $691,827 , respectively. Because each CRAT had a basis of zero in the crops, they realized profit s of $469,00 3 and $691,827, respectively, on those sales. See § 1001. The corn and soybeans were ordinary income property in petitioners’ hands. See § 1221(a)(1) (defining “capital asset” to exclude “property of a kind which would properly be included in inventory of the taxpayer ”). The crop sales were effected in the ordinary course of business by Co - Alliance LLP, in whose grain elevators the crops had been stored. In responding to the Motion for Partial Summary Judgment, petitioners do not contend that the corn and soybeans were capital assets in the hands of the CRATs.7 CRAT I and CRAT II thus realized ordinary income of $469,00 3 and $691,827, respectively, upon sale of the crops, just as petitioners would have done if they had sol d the crops the mselves. Under the statutory ordering rules, annuity amounts distributed by a CRAT to its life beneficiaries are treated first as ordinary income, to the extent of the CRAT’s ordinary income. See § 664(b)(1). All ordinary income must be distributed befo re any other category of income, including nontaxable return of corpus , can be deemed to be distributed . See Miller , 98 T.C.M. (CCH) at 88 – 89. Accordingly, the annuity distributions of $83,440, $206,967, and $206,967 for taxable years 2015, 2016, and 2017, respectively, are characterized as ordinary income to petitioners . 3 . Petitioners’ Arguments Petitioner s ’ response to the summary judgment motion is not a model of c larity. As best we can tell, they appear to make three arguments. None has merit. a. Stepped - Up Basis Petitioners a dvance two theories to support the proposition that the CRATs acquired a stepped- up basis , rather than a zero basis, in the [*11] corn an d soybeans. First, they contend that they sold the crops to the CRATS, so that the CRATs acquired a “cost basis” under section 1012. This argument does not pass the straight-face test. As evidenced by the filing of gift tax return s , petitioners contributed the crops to the CRATs. The re is no evidence that the CRA T s , which had no assets before the crops were transferred to them , paid any consideration that c ould give rise to a “ sale or exchange. ” S ee § 1222. And if petitioners had s old the c rops to the CRATs, they would have had to report additiona l farming income on their Schedules F for 2015 and 2016, which they did not do.
Equally unpersuasive is petitioners’ reliance on the Forms 4797 attached to the CRATs’ information returns . These f orms, prepared by petitioners ’ son as trustee, reported that CRAT I had received proceeds of $469,003 from sale of crops with a basis of $471,000, for a loss of $1,997, and that CRAT II had received proceeds of $691,827 from sale of crops with a basis of $666,975, for a gain of $24,852. Petitioners have supplied no factual support for the basis numbers reported by the trustee, and th ose numbers are utterly implausible. As noted earlier, the c orn and soybeans had a basis of zero when the CRATs acquired them. Petitioners offer no explanation as to how th e CRATs’ bas i s could have been adjusted upward , by more than $1 million in the aggregate , during the brief period in which the CR A T s held the crops before selling them . b . Non t axable Distribution Section 664(c)(1) provides that a CRAT “ shall, for any taxable year, not be subject to any tax imposed by this subtitle .” Citing the “ plain language” of this provision, petitioners assert that a CRAT ’ s distributions to life beneficiaries must also be exempt from tax. In essence, petitioners contend that all distributions from a CRAT constitute nontaxable return s of corpus, because Congress supposedly i ntended that “[t]he donor’s beneficiaries and the charity benefit rather than the Service.” Petitioners cite no legal authority to support their position, and there is none . Section 664(c), captioned “Taxation of Trusts,” provides that the CRAT itself is exempt from tax. Petitioners ignore section 664(b) , which specifies the taxability and character of amounts distributed by a CRAT “in the hands of the beneficiary to who m is paid the annuity.” Section 664( b )(1) mandates that annuity amounts distributed to life beneficiaries are taxable as ordinary income “to the extent of such income of the trust.” As discussed previously, the CRATs received [*12] ordinary income of $469,00 3 and $691,827, respectively, from sale of the donated crops. See supra p. 10. The distributions to petitioners did not exceed those amounts , and those distributions were thus taxable in full as ordinary income.
Petitioners argue that they “should not be double taxed on income from the sale of the asset and then taxed on the annuity proceeds purchased from the sale of the assets.” No double taxation exists: P etitioners paid no tax when transferring appr eciated crops to the CRATs , and th e CRATs paid no t ax on their gain from selling the crops. There is a single level of taxation , expressly mandated by section 664(b)(1), when proceeds from sale of the crops are distributed to petitioners. Petitioners seek to avoid any taxation whatever of the income generated by the sale of their ordinary income property . The Code does not permit that result. c . Taxation o f Annuities U nder Section 72 Lastly , petitioners contend that distributions from the SPIAs should be taxed under section 72 , which sets forth general rules for the taxation of annuities. Section 72(b)(1) generally provides that taxable i ncome excludes any a mou nt received as an annuity “which bears the same ratio to such amount a s the investment in the contract . . . bears to th e expected return under the contract.”
For at least two reasons petitioners err in relying on the general annuity rule s . First, these rules apply “[e]xcept as otherwise provided in this chapter,” viz., in chapter 1 , governing no r mal taxes and surtaxes . S ee § 72(a)(1). Section 664(b), a provision within chapter 1 , specifi es distinct rules applicable t o annuity distributions from CRATs. Thus, to the extent sections 72 and 664 called for different treatment, section 664 would control.
Second, section 7 2 do es not call for different treatment. Section 72(b)(1) allows an exclusion from income only to the extent the taxpayer has an “investment in the contract.” Neither petitioners nor the CRATs had any investment in the annuity contracts . See § 72(c)(1). That is because both contracts were purchased with proceeds from the sale of agricultural crops that had a basis of zero .
To implement the foregoing , An appropriate order will be issued, and decision will be entered under Rule 155 .